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Arbitrators v. Courts - US Supreme Court Reaffirms Prima Paint and Arbitrators Score Again

March 2006
Financial Services Advisory Update, Vol. 3, No. 2

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In the November FSAU, we reported on the decision of the Florida Supreme Court in Cardegna v. Buckeye Check Cashing, where the highest state court in Florida declined to apply the "severability doctrine" (the doctrine that an arbitration clause is considered to be autonomous and thus severable from the contract in which it is contained) in the case of a check casher's contract with its clients. The severability doctrine was first recognized by the US Supreme Court in its 1967 decision in Prima Paint Corp. v. Flood & Conklin Manufacturing Co. and affirmed by the Court in subsequent cases. In Prima Paint, the US Supreme Court applied the severability doctrine in a case in which the plaintiff sought to rescind a contract containing an arbitration clause on the ground that there was fraud in the inducement of the entire contract (thus rendering the contract "voidable"), and held that claims of fraud in the inducement are to be decided by the arbitrators, not the courts, and only charges against the making of the arbitration provision itself are reserved for the courts.

The Florida court's decision rested on its distinction between void and voidable contracts, and the court reasoned that to enforce an agreement to arbitrate when the arbitration clause was part of a contract itself challenged as unlawful would "breathe life into a contract that not only violates state law, but also is criminal in nature..."

The case was appealed to the US Supreme Court, and on February 21, 2006, the Court under its new Chief Justice John G. Roberts, Jr. issued its opinion reversing the Florida Supreme Court's judgment, thereby continuing its line of cases recognizing the Federal Arbitration Act (FAA) as a Congressional declaration of a liberal federal policy favoring arbitration agreements, notwithstanding any state substantive or procedural policies to the contrary. The Supreme Court affirmed its holding that the sole matter for a court to decide in a contract case when the contract contains an arbitration clause covering the parties is a challenge to the arbitration clause itself.

The US Supreme Court first clarified that its prior decisions on this issue established three propositions: "First, as a matter of substantive law, an arbitration provision is severable from the remainder of the contract. Second, unless the challenge is to the arbitration clause itself, the arbitrator considers the issue of a contract's validity in the first instance. Third, this arbitration law applies in state as well as federal courts."

Section 2 of the FAA renders in relevant part "valid, irrevocable, and enforceable" a clause in a contract under which arbitration is required for any "controversy thereafter arising out of such contract." The Supreme Court refused to follow Cardegna's interpretation that Section 2 of the FAA requires a valid contract and thus is inapplicable to contracts that are void at the contract's inception. The Supreme Court held that the term "contract" should not be read so narrowly, but rather should be read to include such contracts that later prove to be void. In reaffirming its ruling in Prima Paint , the Supreme Court concluded that "regardless of whether the challenge is brought in federal or state court, a challenge on the validity of the contract as a whole, and not specifically to the arbitration clause, must go to the arbitrator."

The opinion is available here.

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